How does arena matching work?

It's somewhat random. But, yeah, running into teams like that even with an unmerged team is possible, and even likely, depending on what team you're in.

It's all about skills and bst I guess.
Mages have lower stats in comparison to, for example, an armored unit. But a +10 low BST mage can have the same total stats as a armored unit.
So that's why.

Your arena score is affected by your units' BST, rarity, SP cost for skills, merges and active blessings. On top of that, picking Advanced gives you a team a set amount above your score range, which means your opponents will have higher merges.

Examples: Armor is high on BST, mages aren't.
Aether/DC are expensive builds, spd +3 drag back aren't.
Bringing active blessings (in-season + fjorm/gunntra) boosts score, bringing inactive or no blessings doesn't.

I run Celica with one merge, no merges on my Axura (or Flyzura this week), Dorcas, and Nephenee.

I ran into someone with an unmerged Hinoka, a +3 Red Nowi, a +9 BunnMilla, and a +9 SCorrin. NOT JEALOUS. NOOOPE.

I don't even pay attention to the merges on my opponents. I just care about punching them out.